Hyperinflation is that transition period when a paper money is clearly failing as a store of value but has not yet died as a medium of exchange. This blog is to look at this and any other interesting economic issues. Vincent Cate

Monday, June 15, 2015

Stages of Hyperinflation

There is a general pattern for the stages of hyperinflation.
This can also be viewed as the stages of the "death of a fiat currency".
Money can be seen as serving 3 roles. It is a medium of exchange,
it is a store of value, and it is a unit of accounting. As we move through
the stages of hyperinflation the money gradually gives up these 3 roles. Once it has given up all 3, it is dead.

Government spending gets out of control to where deficit is 40% or more
of spending and debt is over 80% of GNP. If this is for a war that the markets
believe will be won and ended so that the government can make drastic cuts in
spending then there is some wiggle room in these numbers.

This goes on for a couple years and investors move towards shorter term bonds.

It becomes clear the deficit is not going back down.

The central bank starts buying up government debt with newly made
money. If they are not naturally inclined to do this the government
changes the laws or people running the central bank. For the rest
of this section I will write as if the central bank were just part
of the government and ignore bond certificates printed by the
government and handed to the central bank as these will become
worthless anyway. With this simplification I will just say,
"the government prints money".

There is capital flight out of that currency and bond sales fail.
If the government let bond interest rates rise to attract bond buyers
the interest payments on the debt would be huge compared to
taxes collected, so they
keep interest rates down by printing more money.
However, the private investors become less and less inclined to "roll over" their
government bonds.

Government is forced to print money to cover their budget and inflation picks up.
The more bonds coming due the worse the printing is. Many short term
bonds can make for huge amounts of printing, even more than the regular budget.

Some people notice prices going up and spend their money
before prices go up more, even for things they don't need yet.
The velocity of money picks up.
People start to realize that the local currency is not a good store
of value, though still used for transactions.
Some people start to use foreign currencies or gold as a store of value.

So many people take money out of their bank accounts and exchange
it for a foreign currency, or gold, or just buy something that banks
are in danger of going under. So the government often freezes bank
accounts. This is very bad for the account holders,
both because times are hard and they can't get their money and also
because by the time they are able to get it their money it is worth
much less.

Wages and prices become indexed to something more stable, like a foreign
currency or gold. So the local currency is losing the "unit of account" function. Wages become paid more often, like weekly or daily
instead of monthly. The velocity of money picks up more.

People start to use a foreign currency or gold as store of value,
even though government may forbid it. The black market starts
in currency exchange.

Interest rates are very high and loans are for much shorter periods. Loans may be for a couple months instead of 30 years. Hyperinflation makes for hard times and many people are forced to
sell their their land or house.
Because of these things the real prices for things usually bought with long term loans can drop in terms of
something like gold. Houses may usually be bought with a bag of some foreign currency. Real estate is very different during hyperinflation and normal times.

People start to use barter or a foreign currency or gold for trade,
even though government forbids it. This is a growing black market
for commerce.
If you trade a fish you caught
for some potatoes your friend grew, neither of you is paying any
taxes on the deal. In general once people are breaking the
law by using a foreign currency for trade they don't pay any taxes
on trade either. The black market is tax free.

Being tax free and with better store of value the black market
eventually grows larger than the legal market.
People no longer worry about the government requirement to use local
paper currency, enforcement is impossible.

A business that follows the law and sells for regulated prices in the local currency can not buy enough new inventory and soon goes out of business. This makes the percentage of the economy that is black market go up.

People start to not want to accept the local paper money.
Regular taxes are down because
hyperinflation has devastated the economy and much of the economy
is now in the "black market".
The government is finding it hard to buy things by printing money,
as so much of the economy has moved to the black market.
It is finding it hard to pay employees enough for them to live
comfortably even though it keeps printing more all the time.
The government is losing economic power.
Tax collectors may be skipping work to tend to their own vegetable garden.
There is a very real risk of the government failing at this step.

At this point the government has some hard choices if it is not going to fail.
It needs to do something so that the "black market" is legalized
and taxable and deficits are nearly eliminated.
It could just legalize a foreign currency or gold.
But then it would forever give up on collecting any "inflation tax".
It could get rid of budget deficits and stop printing money. However, people will still
fear that it could start again at any time and so be hesitant to use that money.
I think the most frequent end to hyperinflation is by
making a new fiat money but with enough governmental changes that
deficits and inflation are under control and people will use the new money.
If they switch to a new currency then the old money is no longer used as a store of value,
or unit of account, or even as a medium of exchange. It has died.

It would be interesting to hear your thoughts on a cashless currency as I think that is where the new currency will be created in order for the governments to have total control. I also think that a one world currency will be the different economies answer to stem hyper inflation and end currency wars, probably overseen by the IMF and world bank. I don't think governments will allow hyper inflation.

People in China did not think the government would allow the stock market to crash, and the government is doing everything they can to keep it from crashing, but it is still crashing. It is the same thing with hyperinflation, it is not that the government permits it, it just happens.

I think crypto-money is the future. I was one of the founders of the "Financial Cryptography Conference" in Anguilla in 1997. See http://fc97.ai/

I think Bitcoin is at least a step toward the future. With many people using it something would have to be much better to replace it.